Assignment 1 ACF

Submit this assignment on or before 1st September, 2010.

Q.1 A firm has two mutually exclusive proposals A and B under consideration requiring
an initial outlay of Rs 1,000 each. Both the projects have life of 7 years with following
cash flows:
Year Project A Project B
0 -1000 -1000
1 50 500
2 100 350
3 250 250
4 300 60
5 400 100
6 450 100
7 500 150

i) Find out the NPVs of both the projects at discount rates between 8% and 20%
at intervals of 2%.
ii) Find out the internal rate of returns (IRRs) for both the projects
iii) Which of the project is preferable based on rule of IRR?
iv) Which of the two projects is preferable if the cost of capital is a) 12%, b) 15%.
v) At what rate of discount the two projects would be equally preferable? And
what does this discount rate mean?

Q.2 Metal Craft Limited has a machine that is considered not up to the standard. The
component produced on it can be ordered to a third party. If done so the increase in cost
of purchase net of the in-house manufacturing expenses would be Rs 40,000 per annum.
The machine can be sold for Rs 80,000 while its book value is Rs 1,10,000 with five
years of remaining life. The depreciation policy of the firm is SLM while the tax rate is
35%. Examine if the machine should be sold or not. The cost of capital is 15%.

Q.3 Lotus Corporation is contemplating replacement of its existing milling machine with
an improved version that would increase the production from 12,000 components per
month to 18,000. Due to improved design the new component would also fetch a better
price of Rs 85 as against existing price of Rs 90 per piece.New machine costs Rs 12 lacs
with additional amount on installation and training of Rs 1.50 lacs to be spent. If
purchased, the existing milling machine would be sold for Rs 3.5 lacs that has a book
value of Rs 4 lacs. The remaining life of the existing machine is 5 years and the firm
follows a policy of SLM for depreciation of fixed assets. The life of the new machine too
is 5 years. Installation of new machine would entail some extra recurring cost. The
operator salary would be increased from Rs 50,000 to Rs 70,000 per month. However it
would save the cost on maintenance and power. While the production would increase by
50% the rise in maintenance cost would be 20% from existing Rs 10,000 per month.
Similarly the power consumption would increase by 25% only from existing Rs 6,000 per
month. There would be no change in any other cost. Increase in working capital may be
ignored. Assuming 40% taxes and cost of capital at 10% examine whether Lotus
Corporation should buy the new milling machine or not.

Prof. Mayur Shah